Management Accounting Level 3 Model Answers Series 4 2004 (Code 3023) ASP M 1697 >f0t@wjy2[2`6zpw4m #
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Management Accounting Level 3 Series 4 2004 How to use this booklet Model Answers have been developed by Education Development International plc (EDI) to offer additional information and guidance to Centres, teachers and candidates as they prepare for LCCIEB examinations. The contents of this booklet are divided into 3 elements: (1) Questions reproduced from the printed examination paper (2) Model Answers summary of the main points that the Chief Examiner expected to see in the answers to each question in the examination paper, plus a fully worked example or sample answer (where applicable) (3) Helpful Hints where appropriate, additional guidance relating to individual questions or to examination technique Teachers and candidates should find this booklet an invaluable teaching tool and an aid to success. EDI provides Model Answers to help candidates gain a general understanding of the standard required. The Board accepts that candidates may offer other answers that could be equally valid. Education Development International plc 2004 All rights reserved; no part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise without prior written permission of the Publisher. The book may not be lent, resold, hired out or otherwise disposed of by way of trade in any form of binding or cover, other than that in which it is published, without the prior consent of the Publisher. 1
Management Accounting Level 3 Series 4 2004 QUESTION 1 REQUIRED (a) Explain what a limiting factor is and how it is relevant to a business. (b) State, and comment upon, the assumptions of cost-volume-profit analysis. (c) Explain, and illustrate with an example, the calculation of a selling price to achieve a specified gross margin %. (7 marks) (7 marks) (6 marks) (Total 20 marks) Model Answer to Question 1 (a) Limiting factor: A limiting factor is anything that limits the activity of a business entity. For many businesses this may be sales demand. For other businesses, however, the limiting factor may be a shortage of supply (maybe temporarily) of a resource that the business uses which then restricts the amount that a business can produce and sell. In such a situation a business should seek to optimise the benefit it obtains from the limiting factor by prioritising the allocation of the scarce resource in such a way as to ensure achievement of objectives to the fullest extent possible. If a business is seeking to maximise profit then the scarce resource should be allocated to products (subject to maximum demand limits on each product) according to the profit contribution that each product makes per unit of the scarce resource. (b) Cost-volume-profit analysis: The assumptions of cost-volume-profit analysis are: Costs can be analysed into fixed and variable elements Total fixed costs unchanged at all levels of activity Variable costs per unit unchanged at all levels of activity Selling price unchanged at all levels of activity Constant sales mix where more than one product The above assumptions are generally recognised as over-simplified and limit the application of cost-volume-profit analysis. It nevertheless remains a useful tool as long as the limitations are recognised and greater sophistication built into the analysis when required. For example, additional analysis can be carried out with changed assumptions regarding selling price, sales mix or cost behaviour. Also, although the linear cost assumption is unlikely to remain valid over the whole potential activity range it may well be valid over a much narrower range of interest. 2
Model Answer to Question 1 continued (c) Sales pricing: The gross margin % is gross profit expressed as a % of sales. If a required gross margin % is specified then the production cost/cost of goods expressed as a % of sales must be (100 - gross margin %). This cost % (ie 100 - gross margin %), expressed as a decimal, needs to be divided into the production cost/cost of goods per unit in order to determine the selling price required. For example: production cost/cost of goods 6.00 per unit; specified gross margin 40% Selling price = 10.00 per unit [ 6.00 (1-0.4)]. Gross profit = 4.00 per unit ( 10.00-6.00) which is a margin of 40% of sales. 3
QUESTION 2 The following data is provided relating to a production cost centre within a factory for a period: Budget: Actual: Overhead 290,320 at output of 10,000 tonnes Overhead 306,720 at output of 12,000 tonnes (the high-low method may be used to establish cost behaviour) Overhead absorption rate 26.80 per tonne (total of fixed and variable overhead) Output 11,600 tonnes Overhead 305,180 REQUIRED (a) Use the high-low method to establish the budgeted variable production overhead absorption rate. (2 marks) (b) Calculate for the period the: (i) budgeted total fixed production overhead and the fixed production overhead absorption rate (4 marks) (ii) budgeted output (ie fully absorbing budgeted overhead at the rate of 26.80 per tonne) (iii) production overhead absorbed (iv) production overhead over/under absorption (v) fixed production overhead volume variance. (c) Explain the difference between a fixed budget and a flexible budget. (2 marks) (2 marks) (3 marks) (3 marks) (4 marks) (Total 20 marks) 4
Model Answer to Question 2 (a) Budgeted variable production overhead absorption rate: Using the high-low method: [( 306,720-290,320) (12,000-10,000 tonnes)] = 8.20 per tonne (b) (i) Budgeted fixed production overhead: Using output of 10,000 tonnes: Budgeted total fixed production overhead = [ 290,320 (10,000 tonnes @ 8.20)] = 208,320 or = [ 306,720 (12,000 tonnes @ 8.20)] = 208,320 Budgeted fixed production overhead absorption rate = 18.60 per tonne ( 26.80 8.20) (ii) Budgeted output = 11,200 tonnes ( 208,320 18.60 per tonne) (iii) Production overhead absorbed = 310,880 (11,600 tonnes @ 26.80) (iv) Production overhead over/under absorption = 5,700 over absorbed ( 310,880 305,180) (v) Fixed production overhead volume variance = 7,440 favourable [(11,600 11,200 tonnes) 18.60/tonne] or [(11,600 tonnes @ 18.60) 208,320] (c) Fixed and flexible budgets: The essential difference between a fixed budget and a flexible budget is that whereas a fixed budget sets a cost budget in advance for a particular level of activity for planning purposes, a flexible budget adjusts expected costs to the actual activity, according to their behavioural characteristics, for control purposes. 5
QUESTION 3 A company is evaluating the viability of investing 800,000 in new manufacturing facilities to enable the launch of a new product. The product life cycle is estimated at six years. The manufacturing facilities would be expected to have a disposal value of 80,000 after six years. Sales demand for the new product is estimated at two levels: High demand Low demand Year 1 12,000 units 8,000 units Years 2 5 20,000 units per annum 16,000 units per annum Year 6 8,000 units 6,000 units It is believed that there is an equal chance of each level of sales occurring. Other details relating to the new product launch include: (1) Selling price: 50 per unit. (2) Contribution/sales ratio: 45%. (3) Depreciation of new manufacturing facilities: 8.00 per unit (based on the high demand estimate). (4) Incremental fixed overheads (other than depreciation of the new manufacturing facilities) are estimated at 110,000 per annum. (5) The product would be charged a 10.00 per unit share of general fixed overheads. (6) Investment in working capital would be 85,000 in Year 0, rising to 120,000 at the end of Year 1. The working capital investment would be released at the end of Year 6. REQUIRED (a) Calculate the expected value of the sales of the new product (in units) for each of the six years. (3 marks) (b) Using the expected sales units from (a) above, and other relevant information, prepare a schedule of the expected project cash flows in each year. (9 marks) (c) Calculate the expected net present value and internal rate of return of the project using the following discount factors: Discount factors: At 10% At 20% (the cost of capital) Year 1 0.909 0.833 Year 2 0.826 0.694 Year 3 0.751 0.579 Year 4 0.683 0.482 Year 5 0.621 0.402 Year 6 0.564 0.335 (8 marks) (Total 20 marks) 6
Model Answer to Question 3 (a) Expected value of sales (units): Year 1 10,000 units [(12,000 + 8,000) 2] or [(12,000 0.5) + (8,000 0.5)] Years 2-5 18,000 units [(20,000 + 16,000) 2] Year 6 7,000 units [(8,000 + 6,000) 2] (b) Schedule of cash flows: Year Expected 22.50/unit = Contribution Incremental Working Capital Net cash sales units 000 fixed costs capital investment flow 000 000 000 000 0 (85) (800) (885) 1 10,000 225 (110) (35) 80 2-5 18,000 405 (110) 295 6 7,000 157.5 (110) 120 80 247.5 (c) Net present value and internal rate of return: Year Net cash flow Discount factors Present values 000 10% 20% at 10% at 20% 0 (885) 1.000 1.000 (885) (885) 1 80 0.909 0.833 72.7 66.6 2-5 295 2.881 2.157 849.9 636.3 6 247.5 0.564 0.335 139.6 82.9 177.2 (99.2) Net present value (NPV) = 177,200 Internal rate of return (IRR) = 10% + [(20% - 10%) (177.2 276.4)] = 16.4% 7
QUESTION 4 Investment Centre A manufactures a single product which is transferred to another investment centre in the same group. Budgets for next year for Investment Centre A include: Sales 3,000 units Variable costs 40 per unit Fixed costs 100,000 Capital employed 250,000 (unaffected by changes in activity) REQUIRED (a) Calculate the transfer price of the product that will achieve a 20% return on capital employed (ROCE) for Investment Centre A. (6 marks) (b) Using the transfer price calculated in (a) above, calculate for Investment Centre A: (i) the break-even sales units (3 marks) (ii) the profit/loss if sales are 2,800 units in the year. (c) If the transfer price is set at 85 per unit, calculate the number of units that would need to be sold for Investment Centre A to achieve a return on capital employed (ROCE) of 16%. (3 marks) (4 marks) (d) Calculate the residual income (RI) for Investment Centre A based on the budget details above and: Transfer price of 90 per unit Cost of capital of 12% per annum. (4 marks) (Total 20 marks) 8
Model Answer to Question 4 (a) Transfer price: Required contribution = 150,000 [( 250,000 capital employed 0.2) + 100,000 fixed costs] 3,000 units = 50 per unit Transfer price = 90 per unit ( 50 contribution + 40 variable costs) (b) (i) Break-even sales units: ( 100,000 fixed costs 50 per unit contribution) = 2,000 units (ii) Profit at 2,800 units: [2,800 units @ 50 contribution) 100,000 fixed costs = 40,000 (c) Units to be sold: Contribution per unit = 45 ( 85 40) Required total contribution = 140,000 [( 250,000 0.16) + 100,000] Required sales = 3,111 units ( 140,000 45) (d) Residual income: = [3,000 units ( 90 40)] 100,000 ( 250,000 0.12) = 20,000 9
QUESTION 5 A company manufactures and sells a single product. Budgeted data per unit of the product is: per unit Selling price 8.50 Variable cost 3.70 Fixed production overhead 2.90 The above fixed production overhead absorption rate is based on budgeted production of 12,000 units per period. Budgeted non-production overhead (all fixed) is 16,800 per period. Actual sales and production for two periods has been: Period 1 Period 2 Sales 11,600 units 12,400 units Production 12,000 units 12,300 units There was no stock at the start of Period 1. The selling price, unit variable costs and total fixed costs were as per budget in both periods. REQUIRED (a) Prepare profit statements, using absorption costing, showing the actual results for each of the two periods. (7 marks) The company wishes to compare the results reported in (a) above with those that would be reported using marginal costing. REQUIRED (b) Prepare profit statements, using marginal costing, showing the actual results for each of the two periods. (7 marks) (c) Explain fully why the profits reported in parts (a) and (b) differ. Calculations are required to support your explanation. (6 marks) (Total 20 marks) 10
Model Answer to Question 5 (a) Profit statement: absorption costing Period 1 Period 2 Sales 98,600 105,400 Production cost of sales 76,560 81,840 (sales units @ 6.60) less o'head over-absorption 870 (300 units @ 2.90) 76,560 80,970 Gross profit 22,040 24,430 Non-production overheads 16,800 16,800 Net profit 5,240 7,630 (b) Profit statement: marginal costing Period 1 Period 2 Sales 98,600 105,400 Variable cost of sales 42,920 45,880 (sales units @ 3.70) Contribution 55,680 59,520 Fixed overheads: Production 34,800 34,800 (12,000 units @ 2.90) Non-production 16,800 16,800 51,600 51,600 Net profit 4,080 7,920 (c) Profit difference: Period 1 1,160 (absorption higher); Period 2 290 (marginal higher) Profit differences are due to the fact that fixed production overhead is included in stock under absorption costing and only charged against profit when goods are sold, whereas under marginal costing fixed production overhead is charged against profit in the period in which the resources are consumed. In Period 1, finished goods stock increased and thus absorption costing reported a higher profit than marginal costing (400 units @ 2.90 = 1,160). In Period 2, finished goods stock decreased and thus absorption costing reported a lower profit than marginal costing (100 units @ 2.90 = 290). 11
QUESTION 6 The following are the budget and actual figures for a period: Budget: Sales: 260,000 (20,000 units @ 13.00) Production: 20,000 units Production costs: Direct materials 61,200 (12,000 kg @ 5.10) Direct labour 69,700 (8,200 hours @ 8.50) Fixed overhead 48,000 (20,000 units @ 2.40) 178,900 Gross profit 81,100 Actual: Sales 257,800 (19,600 units) Production: 20,400 units Production costs: Direct materials 62,496 (12,440 kg) Direct labour 70,227 (8,262 hours) Fixed overhead 48,160 180,883 Increase in stock (at standard) (7,156) 173,727 Gross profit 84,073 No raw material or work-in-progress stock is held. REQUIRED (a) Calculate any six variances (NB not total variances eg total direct material variance). (b) Suggest a possible reason for any three of the variances. (NB one reason for each of the three variances is required). (15 marks) (5 marks) (Total 20 marks) 12
Model Answer to Question 6 (a) Variances: Eight variances may be calculated (any six required). Sales variances: Sales volume profit: 1,622 adverse [(20,000 19,600 units) ( 81,100 20,000 units) Selling price: 3,000 favourable [ 257,800 (19,600 units @ 13.00)] Cost variances: Direct material price: 948 favourable [ 62,496 (12,440 kg @ 5.10)] Direct material usage: 1,020 adverse {[(20,400 units 0.6) 12,440 kg] @ 5.10} Direct labour rate: Nil [ 70,227 (8,262 hours @ 8.50)] Direct labour efficiency: 867 favourable {[(20,400 units 0.41) 8,262 hours] @ 8.50} Fixed production overhead expenditure: 160 adverse ( 48,160 48,000) Fixed production overhead volume: 960 favourable [(20,400-20,000 units) @ 2.40] NB The eight variances total 2,973 favourable which reconciles the budgeted profit with the actual profit ( 81,100 + 2,973 = 84,073). (b) Possible reasons for variances: eg Direct material price (favourable): lower quality material than standard Direct material usage (adverse): higher wastage than standard due to below standard quality Direct labour efficiency (favourable): positive effect of training/supervision There is no direct labour rate variance as the actual rate paid is the same as the standard rate 13